Corporates as Bankers: Bane or boon for economy?

Corporates-in-banking-sector-merge-two-articles

A recent report by an Internal Working Group (IWG) of the Reserve Bank of India has attracted a lot of attention as well as criticism for its recommendations including the one that suggests corporate houses be given bank licences.

Rationale to constitute IWG by RBI:

The IWG was constituted to “review extant ownership guidelines and corporate structure for Indian private sector banks” for important reasons like

  • The total balance sheet of banks in India still constitutes less than 70 per cent of the GDP, which is much less compared to global peers such as China, where this ratio is closer to 175%.
  • The domestic bank credit to the private sector is just 50% of GDP. But in economies such as China, Japan, the US and Korea it is upwards of 150 per cent.
  • India’s banking system has been struggling to meet the credit demands of a growing economy.

There is only one Indian bank in the top 100 banks globally by size. Further, Indian banks are also one of the least cost-efficient. So, RBI Constituted a IWG to look into the ownership guidelines and corporate structure for Indian private banks.

The committee submitted its report last week.

key recommendations of the IWG:

·         The cap on promoters’ stake in the long run (15 years) may be raised from the current level of 15 per cent to 26 per cent of the paid-up voting equity share capital of the bank.

·         Large corporate/industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulation Act, 1949

·         Well run large Non-banking Financial Companies (NBFCs), with an asset size of ₹50,000 crores and above, may be considered for conversion into banks subject to completion of 10 years of operations and additional conditions prescribed.

·         Payments Banks can be allowed to convert to a Small Finance Bank, after 3 years of experience as Payments Bank.

·         Reserve Bank may take steps to ensure harmonisation and uniformity in different licensing guidelines, to the extent possible.

Corporates-as-banks

Positives of committee report:

For Banking Sector:

  • Dilute the Impact of COVID pandemic: The reforms can Fast track the credit disbursment and distribution to businesses in short term to revive the economy, impacted by the COVID Pandemic.
  • Transformation of banking sector in India: If implemented the banks can help in India’s ambition to be a trillion-dollar economy by acceleration of credit to MSME Sector that will also compliment Atmanirbhar Bharat mission.
  • Bank for all: In rural India Co-operatives is still the major banker with no other alternative. If payments banks are allowed to convert in to small finance banks, this could potentially increase competition, especially in the micro lending space, leading to increasing efficiency.
  • Ensuring robust banking system in India: Since India has very less banks in present, even a smallest bank failure is causing ripples in the entire banking system. To avoid such every time RBI and Government is stepping in to rescue. This can be avoided if recommendations are implemented.
  • Can get rid of NPA’s in the long run: The reforms can create a ripple effect and reduce India’s one of long-standing problem in the banking sector. Opening up of more banks will ensure that the underperforming banks either amalgamated or weed out in the long run.
  • Digital banking is feasible: At present due to less competition and capital,banks are investing less in the technology in terms of payment, credit behaviour etc. Reforms can ensure private invest in technology and push the Public Sector Banks also.
  • Corporate houses will bring capital and expertise to banking.
  • Government can focus on other problems instead of rescuing banks frequently with taxpayer’s money. Apart from that Government finances were already strained before the Covid crisis and worsened during the pandemic.

Why the corporate as a promoter of bank being criticized?

One of the most severe criticisms of the report was the recommendation of allowing the large corporate/industrial houses as a promoter of banks. Former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya severely criticised the suggestion for various reasons like,

  • Poor governance under the present structure is the major problem of Indian banking sector. Ex Despite spotting the fault at early stage in IL&FS, RBI did not step up its governance activities and that resulted in the defaulting of the IL&FS.
  • Bank for elites: In the past, Banks were nationalized because they ownership by the private sector was leading to “large concentration of resources in the hands of a few business families”. The allowing of corporate might revive that.
  • Financial crisis in India: 2008 Global Financial crisis was a proof of how risky that the private sector banks are? Trusting them to operate at large scale instead of trust worthy and financially stable government-owned banking system might create a financial crisis in long run.
  • Issue of Connected Lending: 1997 Asian Financial Crisis was a grave example of mingling of big companies and banks. If we allow corporate as a promoter of banks then the connected lending consequence is unavoidable in India.IWG report itself mentions, “it will be difficult to ring fence the non-financial activities of the promoters with that of the bank”.
Connected Lending:

connected lending refers to a situation where the promoter of a bank is also a borrower. There is a possibility promoter to channel the depositors money into their own ventures. Connected lending was the key factor behind 1997 Asian Financial crisis.

 

The recent episodes in ICICI Bank, Yes Bank, DHFL etc. were all examples of connected lending.

  • Inadequate to track: Corporate houses are adept at routing funds through a maze of entities in India and abroad. So, they can bypass the checks and balances and flout the norms.
  • Can Increase Crony Capitalism: There is a high possibility that few corporates control the lending process and influence the lending process. Thereby reduce the competition and can create a Chakravyuhatype of challenge in Indian Economy.

Is Corporate as Banks is new to India?

In February 2013, the RBI had issued guidelines that permitted corporate and industrial houses to apply for a banking licence. Some houses applied, although a few withdrew thei rapplications subsequently.

Only two entities qualified for a licence, IDFC and Bandhan Financial Services. No corporate was ultimately given a bank licence.

The RBI maintained that it was open to letting in corporate companies to open banks. However, none of the applicants had met ‘fit and proper’ criteria.

In 2014, the RBI restored the prohibition on the entry of corporate houses into banking

Solutions:

  • Improve private governance and regulatory capacity:The Committee on Financial Sector Reforms (2008) headed by then RBI Governor observed that it is premature to allow industrial houses to own banks. Though necessary,the reform can wait till private governance and regulatory capacities improve.
  • Regulator side:
    • Regulator has to enhance the credibility of the system by ensuring every deposit is safe especially with better governance.
    • RBI should ensure the checks and balances before allowing corporates to become promoters.
    • Instead of debating with the allowing of corporate is good or bad? RBI can move ahead with the other recommendations which are really beneficial for the banking sector and economy as whole.
  • From Government side
    • Better Legal framework: If permitting corporates as bank promoters than the government not only need to amend the Banking Regulation Act, 1949 but also needs to amend various Acts to curb crony capitalism, liberal whistle blowing policies etc., but they all need strong political commitment.

Way forward:

Though allowing corporate is one of the recommendations of IWG report, there are many other necessary recommendations for reforming the banking sector. RBI needs to reconsider the step to allow corporates, as the report is open for public review till January.

Print Friendly, PDF & Email

Free IAS Preparation by Email

Enter your email address to subscribe to the blog followed by several Rankholders and ensure success in IAS.